Option Price Behavior

As noted in chapter 8, the value of an option is a function of five factors The price of the underlying asset The option s strike price The options time to expiry 

The price of an option is composed of intrinsic value and time value. An option s intrinsic value is clear. Valuation models, therefore, essentially price time value. 

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The price behavior of financial instruments. One of the key assumptions of option pricing models such as Black-Scholes (B-S), which is discussed below, is that asset prices follow a lognormal distribution— that is, the logarithms of the prices show a normal distribution. This characterization is not strictly accurate prices are not lognormally distributed. Asset returns, however, are. Returns are defined by formula (8.8). 

The difference between the price of the option-free bond and the callable bond at any time is the price of the embedded call option. The behavior of the option element depends on the terms of the callable issue. 

Different levels of segmentation are required depending on the go-to-market model and the organization s current capabilities. In our experience, the most valuable segmentation approach is based upon profit potential and needs. On the profit potential side, the key issue is whether or not a customer s profit potential warrants a customized, tailored (with a menu of options), or standard offering. On the customer needs side, we see four different behaviors in purchasing customers will buy on price, service, product attributes, or win-win performance partnerships. 

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